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June 26, 2013

PIMCO’s Gross: Fed’s Right on Ending QE, but Bernanke Spoke Too Fast

Bernanke’s view of the U.S. economy is fogged by his mistaken belief that traditional factors are hurting growth, Gross asserts

PIMCO founder Bill Gross (Photo:AP)

Bond guru Bill Gross believes that Ben Bernanke was on target last week with his remarks about bringing an end to quantitative easing, but he also says that the Federal Reserve chairman’s view of the economy is fogged up by a misunderstanding about what’s holding the U.S. economy back.

“We agree that QE must end. It has distorted incentives and inflated asset prices to artificial levels. But we think the Fed’s plan may be too hasty,” PIMCO’s founder and co-CIO wrote in a comment, “The Fog That’s Yet to Lift,” which originally appeared in the online edition of Barron’s on Tuesday.

The fog, according to Gross, is Bernanke’s mistaken belief that the economy is troubled by traditionally cyclical impediments such as fiscal austerity and rising home prices. But Bernanke is failing to see the structural problems that are truly plaguing the economy, Gross says.

“Wages continue to be dampened by globalization,” he writes. “Demographic trends, notably the aging of our society and the retirement of the Baby Boomers, will lead to a lower level of consumer demand. And then there’s the race against the machine; technology continues to eliminate jobs.”

Bernanke didn’t mention these factors, but they are what will prevent unemployment from reaching the 7% threshold next year, Gross said. He added that the Fed’s inflation views “may be the foggiest of all” because the U.S. is nowhere near the desired 2% inflation rate and is more likely headed into deflationary territory — and “Bernanke has longstanding and deep concerns about deflation.”

“We’re in a highly levered economy where households can’t afford to pay much more in interest expense,” Gross concluded. “Whereas a decade or two ago the Fed could raise the fed funds rate by 500 basis points and expect the economy to slow, today if the Fed were to hike rates or taper suddenly, the economy couldn’t handle it.”

The moral of Gross’ story? Investors who are selling Treasuries in anticipation that the Fed will ease out of the market might end up being disappointed, and Bernanke will have a hard time winning the markets’ trust if he has to change course on QE a few months from now.

“If he has to wave a white flag three months from now and say, ‘Sorry, we miscalculated,’ the trust of markets and dampened volatility that has driven markets over the past two or three years could probably never be fully regained,” Gross writes.